From Dr Desmond Lachman.
Sir, One has to be struck by Martin Feldstein’s failure to as much as mention the very large labour and output gaps presently characterising the eurozone economy in his discussion of European inflation prospects (“A weak euro is Europe’s best means of beating deflation”, November 8).
For it would seem to be those gaps rather than movements in the euro exchange rate that have been the primary factor behind the sharp drop in eurozone consumer price inflation from 2.5 per cent to 0.7 per cent over the past year.
Since the start of the year, the effective euro exchange rate has appreciated by barely 3 per cent. This makes it highly implausible that exchange rate movements can explain much of Europe’s recent disinflation process, especially given the relatively closed nature of the European economy.
A far more likely explanation of the European disinflation process is the fact that overall European unemployment stands at a record 12.2 per cent.
This view would seem to be supported by the fact that disinflation has been all the more rapid in the troubled European periphery where unemployment rates are very much above the European average and where a number of countries are already on the cusp of deflation.
Looking ahead, a markedly weaker euro would certainly be helpful as a counterweight to Europe’s disinflation process. However, should European unemployment remain stuck at 12 per cent over the next two years, as the European Commission is projecting, absent a very large move in the euro exchange rate, there is a very real risk that the overall European economy experiences deflation.
Sadly, this risk is all too likely to materialise given Mario Draghi’s complacency about any European deflation threat.
Desmond Lachman, Resident Fellow, American Enterprise Institute, Washington, DC, US